On August 25, 2023 the Internal Revenue Service issued Notice 2023-62, which provides a critical 2-year delay in the enforcement of new retirement plan Catch-up Contributions rules passed under the Secure 2.0 Act of 2022.
Participants in certain workplace retirement plans (also known as 401(k), 403(b), and 457 plans) have the option of making retirement contributions from employee salary, on a pre-tax basis. These same retirement plans have the option (but are not required) to let employees make post-tax contributions (also known as “Roth contributions”) which allow employees to withdraw such contributions, during retirement, without having to pay tax at the time of the withdrawal. Some retirement plans have elected not to allow for post-tax Roth contributions to avoid a related increase in the cost and complexity of administering the retirement plan.
All participants in these retirement plans are subject to a combined (pre-tax and post-tax) maximum annual contribution limit on employee salary deferrals, which is adjusted annually ($22,500 in 2023). If allowed by the Plan, participants can exceed this limit, if age 50 or older, by making “Catch-up Contributions” up to an additional, annually adjusted limit ($7,500 in 2023).
The Secure 2.0 Act of 2022 modified these rules to require that any Catch-Up Contributions (if permitted by the Plan) made by employees earning $145,000 or more per year, must be treated only as post-tax, ROTH contributions, effective January 1, 2024. This creates complications for retirement plans that have not previously allowed participants to make post-tax ROTH contributions, and forces such plans to take immediate action (before January 1, 2024) to either amend the plan to allow for post-tax ROTH contributions, or prohibit employees earning more than $145,000 per year from making any Catch-up Contributions to the plan.
IRS Grants 2-year Administrative Transition Period
IRS Notice 2023-26 provides much needed relief to these challenges, by clarifying the following:
- Anyone age 50 and over, can continue making pre-tax Catch-up Contributions, after 2023, regardless of income (i.e. even if the employee makes more than $145,000 per year), and;
- Anyone in a 401(k), 403(b) or 457 retirement plan (including employees making more than $145,000 per year) can make Catch-up Contributions on a pre-tax basis during the 2024 and 2025 tax years, and;
- Any retirement plan that does not allow for post-tax Roth contributions during this two year period, will not be deemed to violate the new Secure 2.0 Act rules, provided that, if Catch-up Contributions are allowed, the plan must extend this allowance to all employees, regardless of annual salary levels.
This clarification provides retirement plans with more time to evaluate and implement plan amendments incorporating the above rules.
Clarification Sought With Regard to FICA-exempt Employees
IRS Notice 2023-62 also says the IRS will issue future guidance as to whether the Roth Catch-up Contribution requirement applies to certain state or local government employees who participate in public retirement systems that qualify as Social Security replacement plans. The IRS invites comments on this future guidance, with all comments due by October 24, 2023.
The employee benefits team at Best Best & Krieger will continue to monitor the status of future guidance. For now, sponsors of 401(k), 403(b) or 457 retirement plans:
- Have additional time to amend the plan to allow for post-tax Roth contributions, if not already offered, and;
- May classify all Catch-up Contributions (including those making more than $145,000 per year) as pre-tax contributions, during the 2024 and 2025 tax years, and;
- May want to wait for future clarification from the IRS as to how these rules will be applied to state and local government employees who participate in public retirement systems that qualify as Social Security replacement plans.
- Employers who have already agreed to treat all catch-up contributions after 2023 as Roth contributions may want to contact their record keeper and possibly rescind their earlier action.